Ultimate store of value

Puru Saxena
Nov 13, 2009

We have been bullish about gold since 2001 but unlike some of the die-hard gold bugs, images of our children living in shanty towns do not keep us awake at night. In our view, gold is not a mystical metal, rather it is the ultimate store of value which tends to do well when fiscal and monetary policies are poor. On the contrary, the yellow metal does badly when the financial system is stable and confidence in central banking is running high.

It is our contention that the macro-economic environment has never been better for gold and the following factors will cause its price to rise:

a. Rising investment demand – We are living in treacherous times where the policymakers are committed to destroying the purchasing power of paper money. Wherever you care to look, central banks are inflating the supply of money and they are encouraging debt growth. Furthermore, most nations do not want a strong currency and they are engaged in competitive currency devaluations. Under these spooky circumstances, more and more wealthy investors will turn to gold as a safe-haven for their savings. As the money-printing intensifies in the future, we are certain that various creditor nations will also try to protect their foreign exchange reserves by increasing their positions in physical gold. Figure 1 shows that gold holdings as a percentage of international reserves have declined for three decades but this may be about to change.

Figure 1: Will governments start buying gold?

Source: The Tudor Group, IMF

b. Shrinking supply – It seems to us that the supply of gold will contract over the following years. It is interesting to note that the mined supply of gold peaked a few years ago and it is now in decline.

In addition to this reduction in production, central banks have recently signed another 5-year agreement which will limit their annual gold sales to 400 tonnes or 14.1 million ounces. This ceiling represents a reduction of 20% when compared to the previous agreement which permitted annual gold sales of 500 tonnes. Therefore, the new arrangement will further remove supply from the gold market.

c. Scarcity factor – Throughout history, only 165,000 tonnes of gold has ever been mined. At today’s price, all this gold is valued at almost US$5.5 trillion which is a tiny sum when compared to the gigantic pools of base money in circulation. Remember, central banks are currently sitting on US$8 trillion worth of paper money reserves and the broad money supply on a global basis is a whopping US$60 trillion! As governments all over the world desperately create money out of thin air, it is our view that gold’s value will appreciate as its scarcity relative to printed currencies increases.

In parting, we firmly believe that the investment demand for gold will increase in the future. Fortunately, for the gold bulls, this incremental demand will be met by sales from current owners who will want a much higher price as compensation for parting with the ultimate store of value during these turbulent times.

Puru Saxena publishes Money Matters, a monthly economic report, which highlights extraordinary investment opportunities in all major markets. In addition to the monthly report, subscribers also receive "Weekly Updates" covering the recent market action. Money Matters is available by subscription from www.purusaxena.com.

Puru Saxena is the founder of Puru Saxena Wealth Management, his Hong Kong based firm which manages investment portfolios for individuals and corporate clients. He is a highly showcased investment manager and a regular guest on CNN, BBC World, CNBC, Bloomberg, NDTV and various radio programs.